Bad news is good news for the stock market

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We live in a curious world. Let’s do a quick recap of the last week to explain why.

Equities have been abhorrent this year. Last week capped off what is the longest streak of quarterly losses since the 2008 financial crisis. Sentiment is as bad as it has ever been and the economy is, by all accounts, going down the tubes.

Then we entered this week, faced with the all-important US employment numbers. First-time jobless claims came in at 219,000, up from 190,000 a week earlier. The worse-than-expected numbers underlined the fear in the markets, with the word “recession” squarely in the mouths of analysts everywhere.

And so the market rallied to commence the week – stringing together its best two-day period in two years. What?

The Federal Reserve dictates stock prices

With the worse-than-expected job figures, the market speculated that the Federal Reserve may have to soften its previous stance regarding high interest rates. The market previously anticipated that the Fed would stay true to its word – that is, that inflation is the number one priority.

To rein in inflation, interest rates will be hiked. This serves to increase borrowing costs, sucking liquidity out of the economy and suppressing demand. Down comes inflation thereafter. Higher rates hurt all kinds of people – those with credit card debt, investors, and companies’ income projections.

The latter is the reason that tech stocks have been absolutely hammered this year. This sector is valued based on free cash flow. That means analysts like to discount future cash flows back to the present. Oftentimes, these companies don’t make profits now and hence are dependent on future projections.

With higher interest rates, there is a greater discount back to the present of these cash flows. This reduces the perceived value of the company and hence the stock price comes tumbling down.

So with the bad news coming in on the job front, the market speculated that the Fed may follow a less aggressive stance on interest rates than previously planned. Therefore stocks jumped up on this optimism of a future of lower interest rates.

Does any of this make sense?

The headline is not facetious. It literally is a case that bad news is good news. I have written a lot recently that of all the variables, the only one that really matters is the words coming out of Federal Reserve chairman Jerome Powell’s mouth.

This market is hinging upon interest rates, which in turn are seemingly dependent on the perceived health of the economy and the ability for it to withstand higher interest rates, as well as the all-important CPI readings.

And so that leaves us in a spot where bad news causes stocks to jump. The next report is out today – the US labour department could have already announced its numbers by the time you read this.

Don’t be surprised if the numbers are below expectations and yet stocks see a mini-rally as a result. For the foreseeable, that’s the world we live in.

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